The typical life cycle of an investor

life cycle

Most people struggle with working out how to invest their money. Do they upgrade their home, contribute more into super, buy an investment property, invest in the share market, or something else?

In fact, this common challenge was the reason that I decided to write my book, Investopoly. I knew that if people understood the fundamental financial planning concepts (i.e., the 8 rules outlined in Investopoly), they might be able to figure out the answer themselves.

Whilst everyone’s situation is different, this blog sets out some common steps that people take at different stages in life.

Starting out…

The first thing you must master, is cash flow management. Once people have their first full-time job, they must learn how to effectively manage their money to create good saving habits. I recommend paying all discretionary expenses from a separate account so that you can track your total spend every week, fortnight or month, as discussed in this blog.   

The goal with establishing good cash flow habits is twofold. Firstly, good cash flow habits will serve you very well for the rest of your life. Secondly, if you can save regularly, it proves that you have surplus cash flow which you can use to service a mortgage i.e., you are ready to buy a property.

Once you have mastered your cash flow management, your next most important goal is to buy your first property. Buying property is the best thing to do because of the leverage it allows (i.e., borrowing). People starting out may have a decent income but few assets. Therefore, their main goal should be to accumulate a stronger asset base. Borrowing allows you to use a relatively small deposit to increase the amount you invest. It’s not about property per se, it’s all about gearing, as explained in this blog.

If you have demonstrated that you have surplus cash flow but don’t have enough deposit, you should investigate whether you are able to use a family guarantee to allow you to get into the property market sooner.

Before you start a family

Typically, people in most occupations enjoy relatively regular promotions and higher incomes after they have more than 5 years of work experience. And if they are managing cash flow well, this higher income should translate to more surplus cash flow.

The question is what to do with that additional cash flow.     

According to ABS data, more than 75% of couples ultimately choose to have children. This needs to be a considered because starting a family is expensive. Your family’s income will fall, as one or both parents stop working to look after your child and expenses are higher, particularly if you use childcare. You must plan for this in advance.

If circumstances allow, I typically counsel clients to upgrade their property as soon as possible but certainly before starting a family. This could include retaining their existing property and converting it into an investment or selling it to crystalise the equity and reinvest that cash into a better-quality property, albeit a home.  

If they do this in advance of starting a family, it leaves them enough time to accumulate a cash buffer (savings), which they can utilise in the future.

Whilst you have young children (starting a family)

Building wealth whilst you have young children (babies) is almost nigh on impossible for the reasons stated above i.e., lower income and higher expenses means you have very limited surplus cash flow. There are typically two windows of opportunity to invest; before you start a family or once your children are in school.

Unfortunately, if you are in this stage of life, there’s not much you can do to advance your financial position, especially if you don’t have any surplus cash flow.

Once your kids are at school

When your kids are in school, parents tend to recover their earning capacity and expenses normalise (no more childcare). This gives people the opportunity to advance their financial position.

A portion of their surplus cash flow should always be directed towards debt repayment, especially if they have a home loan. Upgrading your family home is a priority too (if it’s your goal to do so), as the longer you delay an upgrade, the more after-tax dollars it will cost you, as property prices tend to trend higher over time.

Also, a portion of their cash flow should go towards acquiring more investment (growth) assets, if possible. This can include borrowing to invest in property, maximising super contributions and/or regular share market investing (as explained here). It is important that they accumulate enough growth assets as soon as possible to give these investments plenty of time to appreciate before they need to fund retirement (which for most people is around 60 years of age).

Invest before you need to pay for private school fees

If you plan to send your children to a private secondary school, then you must realise that there is a window of opportunity whilst your kids are still in (public) primary school to borrow to invest in property i.e., before private school fees begin. Of course, you must ensure that any new borrowings are still affordable, even when you have private school fees.

It is important to note that banks will now include private school fees when calculating your borrowing capacity. As such, you may not have sufficient borrowing capacity to invest after your kids have already started at private school.

Enjoy greatly improved cash flow in your 50’s

Typically, clients begin to enjoy greatly improved cash flow in their 50’s, particularly as kids finish secondary school. This is very much a consolidation stage. Hopefully, by now you own enough growth assets. As such, you should focus on consolidating their financial position by maximising super contributions, reducing/offsetting debt and possibly continuing to invest in shares.

Debt reduction is an imperative thing to do in this stage because it is important to ensure you have a much lower interest rate sensitivity in retirement. That is, since you are solely reliant on investment returns in retirement, you don’t want your cash flow to suffer if interest rates increase.

However, if you still have too much debt when you enter retirement, you might have to sell a property to reduce debt, but hopefully you can avoid doing that.

Hooray! Retirement

You can access your super from age 60 if you have permanently retired from the workforce (or age 65 of you are still working). As discussed in this blog last year, the best way to draw your super is to take an account-based pension. That means drawing a percentage of your super balance each year (the minimum is 4% p.a. if you are under 65). You can draw more if you need it.

How long your super lasts depend on your starting balance, how much you spend and your net investment returns. The purpose of investments outside of super (such as property and shares) are to help you fund retirement if/when your super runs out. Therefore, it is possible that you may have to divest of other investments 10 to 20 years after you have retired. However, using super first gives these assets more time to benefit from compounding capital growth, as illustrated in this chart.

Of course, you can’t take your money with you when you die, so you will probably have to sell your investments at some stage anyway. If you expect to have surplus investment assets, you might be able to pass on your wealth before you pass away (ensuring you leave enough money for yourself).

One size does not fit all

This blog sets out a typical investment life cycle but, of course, it is a generalisation. Everyone’s situation and goals are different and as such, their investment strategy must accommodate these differences.